The Mortgage Term

In simple words, the mortgage term denotes the specific period for which a lender loans an amount to a borrower. On the expiry or this mortgage term the lender is entitled to demand the repayment of the outstanding principal amount and accrued interests, if any. In the instance of the borrower failing to return the due loan amount and the interest, he or she will be termed a defaulter.

Unlike in the prevailing situations, long back, the lenders offered loans for extended periods of time, sometimes even for 30 years, on a simple or fixed interest rate that was applicable for the entire period of the credit. However, if such long term mortgage loans at a fixed rate of interest are modified to calculate the interest at much smaller periods ranging from one to five years, the credit would not only earn the lender more money, but also attract many people to the mortgage business.

Keeping this in view, an amendment was made effective in the mortgage business, and as expected more and more investors joined the league. Soon after the amendment, long-term mortgage loans became a thing of the past and most lenders favored loans with a maximum term of five years. However, still there is exception to this trend as most banks and large investors continued granting long-term loans to specific and favored clients and in some cases of private loans. Presently, the most favored and widespread mortgage terms are for seven-year and ten-year periods.

It may be mentioned here that these days nearly all trust and mortgage loan firms are tendering high rate of interest to the public for making endowments in five-year certificates of debts and debenture bonds. On their part, the trust and mortgage companies lend the amount invested by the public to the mortgagors at a higher rate of interest. Normally, these firms charge the borrowers two per cent higher than what they give the investors. In such instances, it is important that the term of the mortgages correspond to the five-year term of the certificates and debentures to enable the trust and mortgage firms to make handsome profits without utilizing their own money.

Supposing an individual borrows an amount with a repayment schedule amortizing the credit over 20 years and the mortgage having a five-year term, in effect it would denote that the 20 year amortization notwithstanding, he or she would be required to reimburse the unpaid loan principal at the end of each five year. This example will help you to deduce that irrespective of the amortization period of a loan, it has to be repaid according to the agreed term of the credit.

The table presented below illustrates an instance of a loan worth $20,000 at 9.5 per cent annual interest that is compounded twice a year or semi-annually with an amortization period of 20 years. The table provides a detailed break-up of the outstanding principal amount at the end of each year of the loan. Study the table carefully to comprehend its calculations better.

Year   1 - $19,640
Year   2 - $19,240
Year   3 - $18,820
Year   4 - $18,340
Year   5 - $17,820
Year   6 - $17,240
Year   7 - $16,620
Year   8 - $15,920
Year   9 - $15,160
Year 10 - $14,340
Year 11 - $13,420
Year 12 - $12,420
Year 13 - $11,320
Year 14 - $10,120
Year 15 -   $8,800
Year 16 -   $7,360
Year 17 -   $5,760
Year 18 -   $4,020
Year 19 -   $2,100
Year 20 -     $0.00

The table displays that the entire loan of $20,000 will be repaid at the end of the 20-year amortization period. However, it is interesting to note that if lender wants his money at the end of every five years, as may be in the case of a five-year term loan, the credit will prolong even after the stipulated 20 years as the interest will be compounded semi-annually, while the money is paid annually.

In the above instance, if the lender wants his due principal amount after every five years, the borrower will have to pay $17,820 on the completion of the first year. In this case the debtor will need to commit him or herself to another five-year term mortgage worth $17,800, which the additional sum that has to be paid on the loan worth $20,000. When the debtor commits for another five-year term mortgage with other factors remaining constant, he or she will be paying $17,479 at the end of the next year, $17,123 on the completion of the second year, $16,749 after the third year, $16,322 after the fourth year and finally another $15,859 at the end of the fifth year of the new loan. Just take a look at the calculations below for a better understanding of the subject. The balance payment for the next or second five-year period after the first payment of $17,820 will be as following:

Year 1 - $17,479
Year 2 - $17,123
Year 3 - $16,749
Year 4 - $16,322
Year 5 - $15,859

The process will be repeated after the payment has been made for the above five years. If we repeat the process two more times, we will be at the end of the fourth five-year term of the mortgage. The payments to be made during the third five-year period, when the outstanding loan amount is $15,800, will be like this:

Year 1 - $15,515
Year 2 - $15,199
Year 3 - $14,867
Year 4 - $14,488
Year 5 - $14,077

At the beginning of the fourth five-year mortgage term the outstanding principal amount will be $14,000 and the payments for the last five years will be as following:

Year 1 - $13,748
Year 2 - $13,468
Year 3 - $13,174
Year 4 - $12,838
Year 5 - $12,474

It may be mentioned here that at the monthly payments end of each five-year term will become lesser than the previous as the principal loan amount becomes smaller after each term. Although it may appear to be surprising, the fact remains that pursuing the five-year term pattern, if the borrower begins each new five-year term with the outstanding principal amount at the end of the preceding five-year plan and the amortization period of 20 years, the loan will never be extinguished.

On the other hand, the borrowed amount would have been reduced to zero at the end of 20 years provided the mortgage term had been fixed for 20 years. However, in this case the monthly payments made by the borrower would either have remained stable or been more than what he or she would be paying under the provisions of the reintroduced five-year terms.

In the instance of retiring or completely repaying a 20-year mortgage loan in 20 years, it is essential that every time the mortgage is refurbished the outstanding principal amount is amortized for period not more than the remaining years in the original amortization of the loan. For example, if the original amortization has 10 years remaining, the paying off period for the renewed mortgage should never exceed 10 years.

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